Pages

Monday, October 12, 2015

The Changing Investor Menus of Acquisition Finance

Low interest rates have encouraged investors to increase
their risk appetite in search of yield. Issuers and arrangers have accommodated
them with aggressive deals and financing structures; thereby supporting growing
M&A volume. These usually work out until something happens. The August correction
is one of those things. Investors, post correction, have paused to reassess
their marked down portfolios, and have reduced their risk appetites. This
presents problems for unfunded deals structured in the pre correction 1H15, but
are only now coming to investors for financing. We previously examined this
problem in 2013 with Rue21 in
which the loan underwriters incurred large losses.

A current example of the same problem is FULLBEAUTY BRANDS
(Beauty). Beauty is an on-line plus sized clothing retailer owned by PE firms
Charles and Webster Capital since 2013. In March this year Beauty levered up to
pay its owners $215 Mln via a special dividend,
and announced plans
for a summer $250 Mln IPO. The IPO window was wide open at that time. It
subsequently closed late summer resulting in its owners switching to plan B-the
sale of the firm. Apax, the same PE firm as in Rue21, agreed to acquire
(secondary buyout) Beauty for undisclosed amount funded in part by $1.650B in loans
underwritten by JP Morgan Chase, Goldman, Jefferies, and Deutsche. JP Morgan Chase and Jefferies were also
involved in Rue21.

The loan underwriters are experiencing sluggish demand for
the loans based on several factors. First, increased concern over a slowing
economy is dragging down retailer prospects. Next, the deal is highly levered
at 6.7X, which exceeds bank regulatory guidelines
and reduces the potential investor base. Non bank loan investors (CLOs) usually fill the
gap, but have suffered portfolio losses during the summer correction. They are
becoming more credit quality sensitive-especially toward higher risk second
lien loans.

The Beauty loan syndication is still a work in process. The
underwriters’ options, absent a rebound in investor risk appetite, are somewhat
limited. Attempts to increase loan pricing or reduce leverage are unlikely to
be received well by Apax, absent bear market pricing or structural flex
provisions. More likely, they will be forced to offer deeper discounts at their
expense (loss) and hold larger than planned portions on the loans.

Like war, most of the time acquisition finance is calm and
boring. It is, however punctuated by brief moments of terror when investors
risk preferences changes.

No comments:

Post a Comment

About MergerProf

In addition to their day jobs, Joe and Ralph teach acquisition finance at the Amsterdam Institute of Finance. This blog was created in the summer of 2012 as a tool for those interested in acquisition finance and related material. Admittedly, we define related material broadly to include mergers, private equity, banking, governance, deal making and, well, finance in general. We hope you will enjoy and contribute, critiquing, expanding and providing your own examples related to the posts. We encourage you to join us in this adventure and, for some of you, to see you in Amsterdam, New York or Philadelphia.